County gambling with derivatives

The article tells how the county's pension fund, only 79 percent funded, is using debt-laden derivatives, allegedly to protect the portfolio against big losses. The county's fund is buying futures contracts tied to the performance of stocks, bonds, and commodities. "San Diego County's embrace of leverage comes as many pensions across the U.S. wrestle with how much risk to take as they look to fulfill mounting obligations to retirees," says the Journal. Other funds are cutting back on risk and simplifying investment approaches. The county fund manages $10 billion for more than 39,000 employees.

Although plans have not been finalized, rumors are that the gamble could be as much as 95 percent of the fund's assets — possibly, "market exposure of $20 billion despite only managing half that amount," says the Journal.

The publication gives credit where it is due: on Sunday, Union-Tribune columnist Dan McSwain brought the pension fund's "casino attitude" to the attention of the community.

Comments

In addition to the risk taken on by the County pension system, the fees paid are ENORMOUS. $10 million dollars ain't chicken feed. Combine that with the fund's short term ranking and everyone should be wondering about the Board's judgement.
But to be fair, the County Pension system did respond to the UT's OP/Ed. Their response is here: http://bit.ly/1pnLks0
Overall the County did meet or exceed their stated goals.

JustWondering: Yes, those fees paid by the county fund cannot be defended. And, yes, pension plans are performing well now, because the stock and bond markets are both doing well because of the extremely low interest rates, along with a lot of corporate financial engineering. Despite the recent good performance, pension plans, both public and private, are still underfunded.

Just don't count on those kinds of returns continuing in perpetuity. In fact, the stock market by various measures has been rather flat this year -- following a startling 30 percent gain last year. Best, Don Bauder

I don't believe ANYONE thinks that the returns over the last couple of years will continue. That's why they state LONG TERM goals of 7.75% for the County and 7.25% for the City funds.
The County's 25 year average as of June 30th was 9.43%, nearly two percent more that the expected return. While the City's system returned averaged 9.4% over the past 25 years. More than two percent above the recently lowered expected rate of return of 7.25%.

Yes it is TRUE both systems are still substantially underfunded. But at least for the City system we won't let the politicians or bureaucrats take any of the so-called excess earning, euphemistically called the "waterfall" in the past, from the fund.

While we can't and don't expect such large investment returns in future years, we can and should be pleased with the report of this fiscal's year earnings.
Later this year the Actuarial's report will tell us how these better than expected returns will, most likely, reduce the City's payment on the unfunded liability and that is good for all of us.

JustWondering: Some very smart people are suggesting that economies around the world, including the U.S.'s, will do poorly for a long time. (They have already done poorly for more than six years.) That could mean that pension fund investment returns would be good, because the Federal Reserve and other central banks would continue their extremely low interest rate policies, buoying markets but not helping economies.

That would definitely mean that the people with the best jobs would be government employees. Their pensions would be restored to balance and they would have civil service protection. Their neighbors would not be doing well, of course, and the city's tax receipts would lag. City government employees already enjoy salaries and benefits that are higher than those in the private sector. Best, Don Bauder

7.25% is a very high expected rate of return unless there is a fairly high degree of risk involved. It's hard to find too many non-volatile asset classes which meet that rate of return. U.S. stock indexes have exceeded that average over a long period of time - but that was during a remarkable era as the US rose to prominence as a global economic and political superpower.

eastlaker: Back in 1996, Mayor Susan Golding tapped the city pension fund to help pay for the Republican convention. As a reward for tolerating the theft, city employees were given further pension benefits that the city cannot pay (unless funny money keeps markets buoyant). So the problems actually date back more than ten years. Best, Don Bauder

Could you as a writer and your weekly move into the 'Golden Age of Debt'

The period you frequently references is the start of the ‘Golden Age’
When the courts ruled that a city could increase their workers
Benefits while decreasing the yearly amount funded.
The city of San Diego is slowly sliding deeper and deeper into debt. This massive debt is
a privilege afforded cities, counties, states and the biggest debtor
of all the feds. Debt has become a monster as in an 1/8th of the USA economy. Look
at the conditions of the streets, the quality of life on the trolleys,
the vacant buildings, the homeless and the pockets of trash.
Like Detroit, the Post Office, Amtrak, Argentina, GM, Stockton and
Iceland the debt of the city of San Diego will be nationally socialized.
Nothing to worry about.

Clockerbob: And after San Diego's debt is nationalized, the Federal Reserve will print more money to pay off the debt. Some say the Fed can't raise interest rates now, even if the economy recovers, because higher interest rates would make it impossible to pay the national debt. Best, Don Bauder

"because higher interest rates would make it impossible to pay the national debt. Best, Don Bauder"
Donald the USA nationally debt is a number we can never repay as Iraq
knows when Iraq ask us to intercept Oil Tankers from the Kurds, send troops
against ISIS, take back the oil wells in northern Iraq from the
Kurds, drop aid to the mountain people, break the blockade of
the mountain people, accept 20,000 Iraq political refuges a year into the USA at a cost of $50,000 per and pay, supply and train the Iraq troops all on the dime of the USA taxpayer. Join with Detroit, Gm, the banks, Argentina, post office, amtrack, Stockton and party into the 'golden age ' of debt.

clockerbob: I don't necessarily agree that the Fed can't raise rates because we couldn't pay off the national debt. I find it a provocative argument. But I have been railing against excessive government and household debt for decades. Today's low rates encourage even more debt. Best, Don Bauder

The Obama administration is preparing to significantly increase U.S. diplomatic, military and economic assistance to Iraq now that Prime Minister Nouri al-Maliki has stepped aside
the 'golden age of debt' Iraq getting a big slice to party with.

clockerbob: Bush Sr. told Bush Jr. that if he invaded Iraq and went on to Baghdad, the U.S. would own the country. Bush Jr. listened to Cheney instead of his daddy. The rest is very ugly history. Best, Don Bauder

If we can elect enough Republicans we can eliminate all our debt problems by eliminating pensions and Social Security and Medicare and Medicaid. More money for the war machine and for the 1%. I can't wait for 2016 so McCain can be Secretary of State. (Bomb, bomb Iran). We can elect Republicans and at the same time invest in the future and present poverty for the majority of American (hourly) workers. Let them eat cake!

At least the Tea Party guys are discussing the national debt as a major issue which is more than the Republicrats are doing. Of course as you say they don't seem to be serious about scaling back our military.

I think at the national level we do need to get serious about eliminating the long term debt - and I think ALL of the following are needed:

ImJustABill: I agree that the SS and Medicare eligibility age should go up, but it should not be a big or rapid increase. Something incremental. Yes, there should be big cuts in defense spending, as well as a general recognition that the United States is not responsible for keeping peace everywhere in the world.

I don't agree with a big tax increase across the board. The middle class is really hurting. A big tax increase could dent the economy severely. Of course, there should be big increases in taxes on the very wealthy. There should also be criminal cases against those who stash money in offshore havens to avoid taxes and/or regulation. Corporations should not be allowed to keep earnings overseas in low-tax nations. Corporations should not be permitted to buy a company in a low-tax nation and then pretend it is moving headquarters there. Since this is a lie -- the headquarters are NOT moved -- there could be criminal penalties for this activity. This kind of monkey business has been going on for ages in tax havens such as the Cayman Islands and pro-business states such as Delaware. This should be stopped.

Private equity groups should not be permitted to take over a company, pile debt on it to pay themselves a fat dividend, and then watch the company asphyxiate or die. More executives should go to prison for using misleading accounting to inflate earnings. The list goes on and on.

I do think an across-the-board tax is risky and admittedly pretty unfair at this point based on how far the pendulum has swung in favor of the wealthy. But I also think it's a bit dangerous to have taxes which only affect one group. I think a small tax increase across aboard with a significant tax increase at the upper income ranges would be reasonable.

I think clearly there should be significant tax increases on the wealthy - the distribution of income needs to be tweaked a bit or we are going to have some real instability in society.

Tax havens are a growing problem and I think there's been a change in accounting attitudes and ethics to a state where "everything's OK as long as you don't get caught" or you have enough lawyers and accountants. Laws need to change quickly to keep up with loophole changes. But that's pretty hard to do even if our Congress was working great. Of course, if corporate leaders took some responsibility that would solve a lot of problems.

Ultimately fraud needs to be punished with imprisonment. How many leaders of AIG, GS, BofA, Lehman whose fraudulent acts were major contributors to the mortgage meltdown are in prison? Not too many as far as I know.

ImJustABill: You make some very good points. How many executives of Lehman, whose books were cooked egregiously, were punished criminally? None. AIG? None. In fact, I don't know of a single executive whose actions led to the 2008 meltdown being prosecuted. That is shameful.

The U.S. is doing a little about individuals stashing money offshore. Note, however, that most of the initiatives have been against foreign banks -- not domestic banks that help their clients evade taxes through offshore institutions. And the U.S. people caught stashing are usually not named.

A dozen years ago, just about all the main countries were battling money laundering through offshore banks. But the U.S. didn't go along: Sen. Phil Gramm of Texas held up everything. He thought such crackdowns would be an imposition on banks. Finally, after 9/11, the U.S. joined in the effort.

As to corporate offshore and accounting abuses, very little is being done here or abroad. Best, Don Bauder

It is easy to say raise the SS retirement age especially when it applies to inside sit-down jobs. With all the laws that favor employers and few that do anything for employees the majority of hourly workers will not be able to retire with anything but SS. Many jobs, even those that pay well, still leave the majority of workers having to work longer. Take a truck driver. It is hard physically demanding job. Do we really want 70 year old truck drivers out there? What will happen is that these 'hard' jobs will result in massive filing of disability claims. I have done both kinds of jobs and could work in my sit-down job in an air conditioned office until I die but I could no longer do my outside job.

don bauder,
it is not a matter of raising SS pay-ins for those with stout incomes and wealth. It's a matter of eliminating the cap on the maximum amount of taxable earnings. This year it is $117k. If Warren Buffet is willing to pay SS taxes on every penny he makes, why can't everyone else? If you make more than $117k and can't afford the extra 6.2% coming out of your check, then you have way bigger problems.

danfogel: I realize it's a matter of raising the cap, but I also feel that raising the cap is a way of raising SS pay-ins for the high-income, high-wealth folks. So we are essentially talking about the same thing. Best, Don Bauder

Well admittedly yes it is easy for me to say raise SS age - I'm just a guy typing away on a computer.

The hard job is actually balancing the budget. That is really hard.

But I would say many (frankly most) political leaders also do something easy: They tell the public that we can balance the budget without big cuts to social security, defense, and tax increases. Somehow future economic growth will magically fix everything.

In 2013 we had roughly a 700B deficit. So to fix that we need some combination of revenue increases and spending cuts that add up to 700B.

I'm proposing something like

100B increase in personal income taxes - shifted mostly to the wealthy.
100B increase in corporate taxes
300B cut to defense (roughly half of defense budget)
100B cut to social security (through age of eligibility increases)
100B cut to discretionary spending (no idea if this is possible or not).

I would certainly not want to do this overnight - probably needs to be phased in over 5 or 10 years. This is just a rough idea of what I think a potential starting point for budget revisions could be.

I'm sure others others would have a different distribution of spending cuts / tax increases. But as I see it a $700B+ deficit means we need a lot more revenue AND a lot less spending.

Sorry, I know that means a lot of people will be hurt unfairly, but as I see it the damage has already been done by decades of bad policies.

In February, the CBO projected the 2014 budget deficit to be $516 billion.
This week, based on tax revenues that are up close to 8% from last year, Forbes is estimating that the deficit will fall to just over $460 billion, down 24% from the same time last year. How do those figures change your "proposal"?
A couple of comments on your proposed cuts. I believe the DOD FY 2014 was about $525 billion. The defense budget will NEVER as low as you suggest. Are you aware of the reform agendas already in place? The FY 2014 budget builds on $150 billion in efficiencies in the five year plan submitted with the FY 2012 budget and another $60 billion in efficiencies in the five year plan submitted with the FY 2013 budget. You will not see another $300 billion on top of that.
You can't simply "change" social security spending and cut itin any way shape or form. Social Security is part of the mandatory spending program. Congress must appropriate whatever funds are needed to keep the programs running as is and cannot reduce the funding for these programs without changing the authorization law itself. Funding can't be changed without, quite literally, an act of Congress, which won't happen. I personally don't have a problem with raising the retirement age. Congress has not changed the age for receiving full benefits since 1983 and it won't be fully implemented until 2017. I think about 2 yrs ago there was a proposal to raise the NRA to 68 by 2023, and the EEA to 65 by 2032 and it went no where. Even if it could be done, it wouldn't be a 5-10 yr process, more like 15-20 yrs.
Finally, I don't have a problem paying reasonably higher taxes. But please explain to me specifically why I should bear the brunt of a tax increase simply because I have more money than other people do.

danfogel: You make some good points. The deficit is falling as a percent of GDP but Americans don't recognize it. Too much noise. The retirement age and the age for collecting SS must rise -- very slowly. Again, the higher-income people should absorb most of this blow.

Those of us who work in desk jobs forget that farmers, miners, and others who do physical labor cannot work as long as we can. Best, Don Bauder

don bauder
we agree on retirement age and the age for collecting SS rising, albeit slowly. But I don't get how "higher Income" people should absorb most of the blow of raising the retirement age and the age for collecting SS benefits. I know that income is a function of how much you collect, but how is income a function of the age at which you can begin to collect?

Projected budgets always look good - it's easy to manipulate expected numbers. I think for a real look at the situation you need to look at the most recent years data where the really numbers come in.

I really don't understand your last question in the context of your post. You explain why it's impossible to make any cuts then ask why you should have to pay more taxes.

Sorry I don't believe that the US government should continue racking up a balance on a gigantic $17 Trillion credit card.

So if you don't want to rack up debt then income has to equal expenses. I'm proposing a combination of spending cuts and revenue increases. The income tax is a very large portion of US federal revenue so I think any major revenue increase has to include an income tax hike. The income distribution in the U.S. is reaching historically high extremes. I think that's a somewhat dangerous situation and one of the ways to address that is with a more progressive tax scheme. So that's why I think the tax increase has to be tilted towards the wealthy.

I agree that projections can be bothersome, However, since the US federal budget funds government operations for the fiscal year, it would seem that with only 43 days left until the end of the fiscal year that the Forbes estimate may be pretty close. As for looking at the most recent data, I agree with that also. The CBO releases FY YTD data each month. In the July report, the most recent I have seen, the FY YTD deficit totaled $365.9 billion, which is 28.2 percent below the same period a year ago. You are free of course to draw your own conclusion. The conclusion I am drawing is that the actual deficit is going to be somewhere between the $516 billion the CBO projected in February and the Forbes estimate of $460 billion. It will almost certainly be well below the $700 billion that you referenced. Not bad considering that the record $1.4 trillion deficit was just in 2009. So in 4 yrs, 2009-2013, the deficit has been cut in half, from 2009's $1.4 trillion to 2013's $680.2 billion and this year it should fall another 20+ percent. Still a long way to go because one must keep in mind that over the next 10+ yrs, spending on the major benefit programs, like Social Security and Medicare, will increases as more boomers begin to retire.
Perhaps you misunderstood my last question. As I said, I don't mind paying reasonably higher taxes, such as eliminating the cap on SS taxable income and I support a reasonable increase in the qualifying age for SS benefits. What I was asking is why you personally think I should pay a much higher income tax rate, a specific reason, which you answered above.

So the debt isn't quite as bad as my post would indicate. Maybe 500B instead of 700B. Still a pretty big number. As you point out it is incredibly difficult politically to cut almost anything. And any major cuts should be done over a long period of time.

ImJustABill
we could go round and round forever on tax increases and probably never agree on how they should be done and how large they should be. For example, I paid over 100k in taxes last year, and while I don't mind paying a reasonable amount more, I don't think it's reasonable that my tax bill should increase by 50%, or more, as some would suggest. I do think a good place to begin would be to rework the tax code, which many are actually in favor of.
Also, to answer one of your other questions above, on cutting discretionary spending. Discretionary spending is a fickle little bitch. Basically, it's money set aside in the budget that Congress can spend at their discretion, when pr as the see the need. So the big pot of money they set aside in the budget could be cut when the budget is written. That's where it gets sticky though. Once it's in the budget, it's theirs to spend. But, when they create an appropriation act that authorize the spending AND appropriates the funds, it then becomes mandatory spending. The problem is the discretionary fund is like the rainy day fund. How do you decide how much to cut it? How do you figure how many natural disasters, humanitarian crises, unbudgeted military actions etc will occur. Every time we hear about POTUS going to Congress for more funding, for Sandy, for wildfires, for humanitarian aid, for what ever, that money comes from the big pot 'o' discretionary funds. I think that sometimes priorities seem to be backasswards. For example, when we have children with no food, shelter clothing and medical care in our own country, they should be provided for ahead of the needs of those anywhere else. You ALWAYS take care of your own first. But that's an argument for some other time.
Bottom line, It discretionary spending could be cut, but if they run out of money, they just spend it anyway and put it on the credit card.

My most cynical view (which I hope isn't true) is that we are maintaining a strong military because we know that at some point we will default on our debt (maybe not an outright default but by manipulating money supplies and fiscal policies in ways which tend to artificially less the real value of our debt).

If the Chinese asks for their money back rather than paying them we will threaten to kill them.

I hope our leadership really isn't that vicious and that I'm just being cynical to think that's actually the plan. But I wonder....

ImJustABill: Actually, federal government debt as a percentage of GDP has been declining. That said, however, the debt is still far too high.

I have another cynical view: one reason we keep our strong military is because the aerospace/defense industry has such powerful lobbyists. Also, do you remember what happened to the Southern California economy when Bill Clinton cut military spending in the early 1990s? Politicians don't want to go through that again. The military is built into the fabric of our society and into our economy and politics -- unfortunately. Best, Don Bauder

Don Bauder
the federal deficit is falling as a percentage of GDP, as you noted above, but I don't believe the federal debt is falling as a percentage of GDP. In fact I can find nothing to indicate that. perhaps you can share where you got that information.

danfogel: Yes, the deficit as a percentage of GDP is falling. The federal debt, at least that held by the public, seems to be declining, too, as the chart below from ImJustABill appears to indicate. It seems to be coming down slightly for 2014. Best, Don Bauder

Well as I said in my comment below, U.S. federal debt held by the public is only one part of the equation and I think it is disingenuous to claim that the debt is coming down based solely on that when the debt as a whole is on the rise. According to the fed, that portion of the debt dropped slightly from 72.2% in Q1 of 2013 to 71% in Q2 of that year. However, since then, it has climbed back to 74% in Q1 of this year and is projected to stay between 72 % and 74 % of GDP from 2015 through 2020.
Perhaps you should look at The 2014 Long-Term Budget Outlook from the CBO. It is somewhat long, around 140 pages, but it is quite interesting and very informative. In fact, I would say it's a must read for anyone desiring to have an intelligent debate on the subject.

danfogel: The forecasts by the CBO and the Federal Reserve are often wrong. However, I would tend to agree that the debt as a percentage of GDP will rise. The deficit as a percentage of GDP is dropping, but will that continue? There are so many variables: military spending, economic growth, etc. Best, Don Bauder

don bauder,
As I said in my Aug. 18, 2014 @ 10:18 a.m.post, due to increased spending on the major benefit programs, like Social Security and Medicare as more of us boomers begin to retire, I am in the company of those who believe the deficit will begin to expand again, probably beginning after maybe 3-5 yrs of reduction. Without significant growth in revenue and/or spending decreases, which I don't think are likely, the deficit as a percentage of GDP will begin to grow again.

Yeah, you know, you have to be careful about relying on wikipedia too much. The chart you show is U.S. federal debt held by the public, which is just one component, the other being government accounts or intragovernmental debt. If you actually look at that chart, it indicates a percentage of GDP of less than 80%, which should be a clue. According to the Fed, the debt as a percentage of GPD dropped below100% in Q3 of last year, but it has risen to 103.3% as of Q1 this year. On a year to year basis, it has risen every year in the last 10 yrs and is projected to rise as high as 106-108 percent of GDP over the next 20 yrs.

danfogel: And a number significantly above 100 percent is too high. Japan's is even higher, but its advantage is that its debt is mainly held by its own citizens, not foreign countries. Best, Don Bauder

don bauder, The last time I looked, Japan's public debt-to-GDP ratio was over 200%, so is the fact that it is held mainly by it's own citizens really a victory? I mean Greece is the country with the next highest debt-to-GDP ratio at 152.5 percent and most advanced economies run between 75% and 110%. I am of the opinion that much of it being held by domestic investors is the only reason Japan's economy hasn't already imploded. Japan has gone thru two decades of rapid, unchecked debt expansion. The only worse debt crisis I can recall is that of Israel back in the 80's and Japan seems to be well on their way to matching if not surpassing that.

danfogel: No disagreement on Japan's situation. We have had low interest rates since the Great Recession that exploded in 2008 (starting in 2007). Japan has had low interest rates for a couple of decades. The country has been in and out of recession -- perhaps depression -- since 1989. The long-running low rates make a difference.

Can you explain why the yen has been so strong for so long? Best, Don Bauder

don bauder
I have no idea as I really don't follow currencies. I leave that to the people who manage my investments.
That said however, I generally have CNBC on somewhere in the house if I'm home. Over the past couple of years, the subject of yen vs. dollar has come up numerous time and generally the same conclusion is reached, which I happen to agree with. Put simply, it's supply vs. demand. More people want to buy the yen than want to sell it. When there is relatively more supply and less demand for the Yen, the Yen weakens. I think the all time high for yen against the dollar was about 3 yrs ago at just under $76.00. It closed today at $102.62, so while not as week as it was back in 2007, it certainly has weekend over the last 3 yrs or so.

danfogel: Well, yes, currency movements are explained by supply/demand EXCEPT when countries manipulate their own currencies, normally downward. That's called a dirty float. It's quite common. I have been following currency movements for decades and find no rational method of predicting them.Best, Don Bauder

Don Bauder
I will have to take your word on that as you are far more knowledgeable in that area than I. I seem to recall that periodically there seems to be a brouhaha over claims that China is manipulating it currency, the yuan, I believe. As I said, I don't follow currencies and don't know much about them.

I don't understand why government accounts or intragovernmental debt should be counted. Seems to me that money could always be shifted around within the government. I would think the big problem is money that the U.S. government owes to entities outside the U.S. government.

ImJustABill: As I read this chart, the debt as a percentage of GDP is falling slightly in 2014. The deficit is definitely declining as a percentage of GDP. There is no question that both the deficit and the debt are too high. Best, Don Bauder

JustWondering: That is impressive, but, frankly, I don't believe pension funds -- public or private, but especially public -- have any business investing in private equity. Given the number of private equity funds the city invests in, it almost has to be putting money through offshore tax and secrecy havens, since half of private equity funds steer their deals offshore, usually to avoid regulation, but possibly also to avoid taxation. A fund working for public employees should avoid such monkey business. Best, Don Bauder

Granted. The delimma is how do pension boards / managers earn returns necessary to sustain the benefits awarded by plan sponsors. Especially when sponsors (political and managerial leaders) are never held accountable.

Seems the County's pension system managers/boardmembers are desperate (maybe too strong of a word) for higher returns to fund benefits granted by the plan sponsor. The obvious loser, the taxpayer who is required to pay for any and all deficits.

JustWondering: Over the long term, I wonder how well private equity groups ACTUALLY do compared with, say, common stocks of blue chip companies paying generous dividends. In my own opinion, the field of private equity is made up of a bunch of crooks. The growth strategy of private equity firms is fraudulent, particularly piling debt on the target company to give fat dividends to the private equity group making the purchase. How do you know that the numbers they report to you are honest? Best, Don Bauder

The questions raised at the end of the piece are thoughtful.
With all the attention focusing on the County's risky plan what are the odds they'll now reconsider their decision and change to a less risky investment strategy?